Investors, particularly those reaching or in retirement, have a particularly significant challenge to understand how combinations of assets they may have accumulated can be deployed and how they may be expected to be able to achieve certain objectives typical of that phase of life, particularly, providing for a steady or gradually changing stream of income for the rest of their lives. Optimal deployments require the coordinated management of fixed and non-fixed income securities relative to specific payout periods as well as of related insurance arrangements to help manage longevity risk. For the vast majority of ordinary investors in, or planning for, retirement, the complexities of this information gathering, evaluation, and coordination prevent rapid, effective and regular decision making with the end result that savings prove to be inadequate, retirement plans need to be altered, and/or year-to-year payouts shift unnecessarily rapidly and unpredictably.
Since 1980, such investors have also become highly dependent on a wide variety of self-directed accounts (OECD Publishing. OECD Private Pensions Outlook 2008. OECD Publishing, 2009. ISBN 9264044388, 9789264044388. p 53) through which they can invest (e.g. IRA, 401(k), taxable brokerage, etc.) and a wide variety of instruments (e.g. fixed income securities such as notes and bonds issued by governments and corporations, non-fixed income securities such as stocks and other equity like holdings, and insurance products such as immediate and deferred annuities).
The wide range of asset allocation choices found within self-directed investment plans focused on accumulating savings for retirement (e.g. IRA, and 401(k)) (Investment Company Institute. 401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2007. Washington, D.C.: Investment Company Institute. December 2008. Vol. 14, No. 3) is indicative of the difficulty many investors in such plans have in making consistent and rational choices about how to allocate their assets towards a particular retirement objective (DiCenzo, Jodi. “Behavioral Finance and Retirement Plan Contributions: How Participants Behave, and Prescriptive Solutions.” EBRI Issue Brief. No. 301, January 2007). This is further supported by the often observed under performance of these plans relative to professionally managed plans, such as pension plans, invested towards similar objectives and over similar time frames. Research in the field of behavioral finance has found that the complexity of communications about options, not to mention the wide range of the options themselves, has caused many self-directed investors to make and maintain sub-optimal choices over prolonged periods of time without any means of periodic self-correction and adjustment (EBRI Issue Brief. No 301, 2007).
One approach to this problem has been to reduce options and to make asset allocation choices more automatic. The advent of balanced funds (containing a pre-determined mix of non-fixed income and fixed income securities) was an early response that created one method for investors to standardize their investment options relative to an objective. This was followed by lifecycle or target date funds that provide for a shifting mix of non-fixed to fixed income securities as an investor ages (Todorova, Aleksandra. “Lifecycle Funds Are Popular, but Not for Everyone.” SmartMoney, Feb. 6, 2007). These have all provided basic methods for further encouraging not only sector and duration diversification but also shifts in these diversifications over time, that begin to approximate best practices utilized by investment professionals; however, these have come at an increased cost to investors as these products are built with layers of funds and accompanying fees. More significantly, these options provide no relationship, however directional, in terms of the ability of these investment choices to achieve a particular payout objective starting at some point in the future. These funds cannot be customized or adjust to an investor's needs. Rather, the investor must first determine what their needs and risk tolerances are, if they can, and then find the fund that most closely matches that need.
Few, if any, of these kinds of fund options differentiate between investments before and after targeted retirement (i.e. where assets shift from periodic accumulation to often steadily periodic liquidations). Fewer still, if any, provide information for their investors relating the level or amount of their investments with an ability, much less a range of possibilities, relating to how long their investments might last when applied to a targeted payout stream or “burn rate” (Dennison, Terry. “Improving Target Date Lifecycle Funds.” Mercer, LLC. Jul. 29, 2009).
The lack of information to investors, even in the most advanced of the lifecycle funds, both in helping to make an initial choice and about the relationship of their asset allocations to an ability to generate a particular stream of income during retirement has been most recently illustrated by the surprise many investors expressed when they realized life cycle funds they thought had been conservatively allocated and represented automatic access to investment best practices turned out to be more volatile than they had expected (Paskin, Janet. “Target-Date Fund Losses Prompt Some to Rethink.” SmartMoney, Feb. 12, 2009). While this relates in part to disclosure about the funds, it more fundamentally relates to the lack of information about the range of volatility the assets of these investors might have and the possible short and long term effects that volatility might have on realizing a steady, multi-year payout. Mere disclosure about the presence of volatility, without quantitative information relating that volatility to the ability to meet a payout objective investors can understand, did little to close the information gap for these investors about how they expected the funds to perform relative to their real world savings and payout objectives.
Most recently, new classes of investment funds have emerged, such as payout funds, that explicitly change the focus of invested assets towards payout in ways that the lifecycle funds had not. Like life cycle funds, these too, contain multiple layers of fees. Different from life cycle funds, they do differentiate between the time that primary investment inflows end and retirement outflows begin. Many, typically, link each immediate period in the payout stream in a fixed ratio to the net asset value of the holdings where, when holdings appreciate by 10%, for instance, the payout for that year increases by 10%. Similarly, when such holdings depreciate by 10%, the payout for that year decreases by 10%. Alternatively, for funds that seek to hold payout steady even as holdings depreciate, larger than expected portions of the invested funds are ratably liquidated, often unnecessarily damaging the ability of the remaining assets to generate needed returns. Such funds continue to lack clear linkage between the assets invested and their allocations to being able to achieve a particular payout stream over multiple years of a given length including communicating even basic information about a range of possibilities inherent in the volatility of the assets in which they have chosen to invest (Mamudi, Sam. “Managed payout funds show flaws: Are new income-focused investments living up to expectations?” MarketWatch. Aug. 22, 2008.).
In addition, though many of these funds provide access to fixed income securities of varying durations, they do so through intermediate funds. Without the ability to manage direct investment in fixed income securities of specific maturities and duration, self-directed investors are deprived of a substantial amount of ability to match the duration of their investments to the timing, and thus the duration, of the outflow stream they wish to be able to generate. This can present significant unnecessary exposure to loss of principle. It also limits the ability to arrange that properly sized, short duration fixed income securities, able to resist short term market swings, are the ones that are primarily liquidate as each payout period arrives—protecting the ability to maintain a particular payout level while also protecting more volatile securities from being the ones liquidated to maintain that payout level during short term (1-2 year) market downturn swings. Professionally managed pension funds depend on such control to obtain superior results with lowered risk (Ennis, Knupp & Associates, Inc. An Asset Allocation Analysis For Frozen Pension Plans. Chicago, Ill.: Ennis, Knupp & Associates, Inc., 2008.); but without such tools, visibility and ability to directly access fixed income securities matched to critical parts their desired outflow stream and that can mature in matched periods, self-directed investors today, even through payout funds, are missing capabilities that can demonstrably improve the ability of their investments to more optimally meet steady or gradually changing payout stream objectives.
Fewer still, if any of these fund and investment options, provide information to their investors relating to what might constitute realistic levels of target payout streams, either in level or the time before they are likely to be exhausted, or to matched insurance-related arrangements that can provide for a continuation of payment after those assets have become exhausted.
The plurality of the differing funds involved further compound the ability of individual investors and their advisors to obtain comprehensive information from any one source about the assets they control and the ability of those assets to produce a desired level of income over an indeterminate period of time, typically the remainder of the life of the investor or a joint survivor. Such comprehensive information needs to include management and matching of current assets which, in combination with an expected stream of payouts, have a probabilistically predictable time over which they will be depleted, and insurance arrangements which, if matched in amount and start time, are able to continue that stream of payouts over the remainder of the life of the investor or a joint survivor. A series of behavioral finance findings reported over the last decade suggest that this complexity will produce sub-optimal investment choices even in those with high levels of financial knowledge (Agnew, Julie R., and Lisa R. Szykman. “Asset Allocation and Information Overload: The Influence of Information Display, Asset Choice, and Investor Experience.” The Journal of Behavioral Finance. Vol. 6, No. 2 (2005): 57-70.) and (EBRI Issue Brief. No 301, January 2007).
Such comprehensive information, if it were available, could help individuals with all levels of financial knowledge by allowing those with high levels to optimize their choices better, those with medium levels of such knowledge to make sufficiently informed choices to break out of habits that have tended to lock them into sub-optimal choices, and even those with low levels of such knowledge to make effective basic choices. While investors at all knowledge levels may have difficulty understanding the full range of multiple asset classes and their relative and interrelating characteristics, there is a higher chance that such individuals can understand the relative possibilities of achieving payouts for certain periods of time matched to their own lives and spending levels and very basic concepts such as the mix of fixed income vs. non-fixed income asset classes. Improvement in information presentation that can lead to better basic investment behavior is an area where improvements continue to be needed and where improvements can help remedy a primary cause of large sets of individuals making sub-optimal investment choices for retirement over sustained periods of time.
As an alternative to managing a retirement payout through self-directed means, there have long existed insurance-based options that do provide clarity between these relationships.
Immediate fixed annuities, that are well known and have existed for some time, and purchased at the beginning of a retirement period can meet such an objective; however, they require that all assets dedicated for such a purpose be immediately transferred to a single account and the guaranteed nature of these investments create their own particular shortcomings for investors. First, by fully transferring risks, most notably substantial periods of investment market returns and longevity, to the insurance company, the insurance company must charge the investor for taking on those risks. Those charges take the forms of material discounts compared to the value of professionally managed investment holdings of comparable size, involve an inherent shift to lower yielding fixed income investments and involve layers of higher fees. Though individually disclosed, the effect of these charges compared to alternative means of achieving the same objective is complex and hard to analyze for the average investor. Further, fixed annuities lack liquidity, cannot be changed once started, and do not respond well, if at all, to inflation.
Immediate variable annuities transfer some market risk back to the investor; however, relative lack of control and highly limited investment options, requirements to pay the insurance companies and their fund managers for all trading activity (with their own multiple layers of fees) as well as the continuing lack of transparency as to the overall effects of fees and utilization of these vehicles continue to leave them with drawbacks which many investors still consider to be too high to extensively utilize.
One measure of this often perceived lack of overall economic value is the comparatively small number of professionally managed pension funds who view a standard termination (by definition the transfer of professionally managed pension assets into annuities) of even frozen pension funds as economically attractive. This is even when such professionally managed pension funds are able to negotiate attractive rates for the bulk annuities they would purchase. The discounts applied to individuals seeking such a transfer are more disadvantageous.
Insurance products also contain inherent charges for the tax free investment protection they provide; however, most investors today have access to other tax advantaged vehicles, such as IRA and 401(k) accounts, able to provide equal advantages.
While the use of annuities or other shared risk, income generating products, nevertheless remain the only viable way to adequately provide for income through to the end of a lifetime, one way to minimize the costs and lack of transparency as well as to maintain the trading flexibility and the ability of investors to choose investment vehicles and trading platforms of their own to minimize fees and maximize performance is to delay the start of the insured period and to allow investors to manage assets on their own through to the start of that period. This is the kind of approach taken by the present invention.
The present invention and its related descriptions hereinafter often refer to “insurance,” “insurance products,” “other shared risk, income generating products” and like terms. Unless otherwise specified—such as in the use of the term “insurance companies” which refers to companies certified and regulated to provide insurance products, such as annuities—these terms are intended to be broadly interpreted to describe a contractual arrangement between an investor and a third party provider, regulated as a provider of insurance or not, to provide income, not necessarily guaranteed, from the start of a particular period (potentially event, rather than date, driven) to the end of an investor's life (or, in the case of a joint survivor, investor's lives). Examples of such other alternative third parties not regulated as insurance companies include, but are not limited to, pension funds.
There is at present no comprehensive way for an investor to directly relate and to manage market and inflation risk and to seek low fee options to generate a steady or gradually changing income stream for much of their expected retirement, while also giving the investor visibility into the potential relationship of matched insurance arrangements that can continue that income stream if their retirement lasts longer than they might expect. In order to do this, the investor must manage their own investments, now directly relative to a desired payout stream, using securities that are going to continue to vary in rates of return over an extended period of time and they must manage both the level and longevity of that stream relative to either their life expectancy (if they chose not to have any insurance products) and/or relative to a set of delayed start or deferred insurance arrangements.
Computerized tools and methods have evolved over time to address some of the shortcomings, however, most continue to address the management of the outflow stream prior to the initiation of coverage by insurance products relative to guarantied levels of payout. They do not address the matching of expected (mean) overall return to the payout stream, support calculated sizing alternatives relative to estimated probabilities of coverage of less than 100% and/or provide matching and linkage to insurance products to keep their levels and start dates matched with the portion of the payout stream being covered by the direct management of assets.
Further, these tools and methods do not provide a means for positive control and linkage of potential requirements of insurance arrangements back to the directly managed assets, inhibiting the introduction and utilization of alternative insurance products that could take advantage of such capabilities to further reduce cost to the investor and increase the amount of their assets, and thus the potential level, of a payout stream during the part of the period (the early years) where they have the highest probability of living to actually benefit from the payout stream.
Finally, though there are many investment performance indices available today, most focus of the expected (mean) performance of an individual security or class of like securities (e.g. publicly available bond and S&P indices). Few, if any, are available to index performance of a disparate collection of investments in a given portfolio of such investments relative to a defined payout stream, much less relative to the probability of that portfolio to fully cover that stream (i.e. to consider the relative size of potential downside outcomes). The latter aspect, in particular, requires that the index be able to reflect the potential for downside performance of a subject portfolio of assets relative to some recognizable reference standard.
No program exists, to the knowledge of the inventor, which can provide investors with manual and automated means of managing assets and insurance products in a coordinated and comprehensive manner to provide for payout streams with associated time extension risk factors, considering and protecting, at least in part, from interest rate risk, one able to identify surpluses and respond to deficits vs. the target payout/liability stream and one that can factor in time extension (e.g. longevity expectations) and market change risks that arise over time. Nor is there a readily understandable means of communicating to investors the comparative ability of differing portfolios to cover such time varying and annuity-like payout liability streams.
The following references are cited to provide additional background information on the invention:
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